Energy sector

1. Evaluation of reform policies of the Parliament and Government during the period of September 2019 – September 2020 and its compliance with the Toronto Principles (based on the analysis of the Government Program, the plans of the ministries and the adopted/rejected regulatory acts)

In 2019, reforms continued, but new challenges emerged. With the change of government, the issue of rebooting the National Commission for State Regulation in the Fields of Energy and Public Utilities was raised again, which was eventually returned to the executive branch of government. Turbo mode, on the one hand, accelerated, and on the other – complicated implementation of some tasks. The new government failed to distance itself from the political factors influencing the reform.

With the change of government in 2019, the Ministries of Energy and Ecology were merged into a single Ministry of Energy and Environmental Protection of Ukraine (hereafter – MEEP), and the responsibility for the formulation and implementation of energy efficiency policy should have been transferred to the former Ministry of Regional Development, Building and Housing and Communal Services of Ukraine (current Ministry of Communities and Territories Development) in 2020. Despite public organizations' reservations about possible conflicts of interest and the receding of environmental issues into the background, the merger still took place. The main reason for that was the need to formulate a comprehensive energy, environmental and climate policy. This logic is acceptable, especially given the experience of other countries and the importance of climate change in the world.

In early 2020, the MEEP presented a work plan for the year and outlined a long-term vision for the development of the energy sector according to the Green Transition Concept. For the first time, it was proposed to completely abstain from the use of coal energy in Ukraine until 2050, as well as to decarbonise the economy until 2070. MEEP proposed to achieve these goals through a focus on energy efficiency and energy conservation, the development of renewable energy sources and electricity, the introduction of a systematic approach to waste management and the digitization of economic processes, the construction of modern energy markets "... with a high degree of openness and competition” by turning the consumers into active market players. These plans can be termed progressive and consistent with the Toronto Principles. At the same time, the proposed key dates were debatable, and required public discussion and finalization. In spring of 2020, work on the concept was suspended.

In March 2020, at an extraordinary meeting of the Verkhovna Rada of Ukraine (hereinafter - the Parliament), a decision was made to reformat the Government. As a result, in May 2020, the newly created MEEP was again divided into two separate ministries - the Ministry of Energy of Ukraine and the Ministry of Environmental Protection and Natural Resources of Ukraine (hereinafter - the Ministry of Environment). This required to adjust the internal work of the ministries. This process is still ongoing and may take a long time.

The situation was also complicated by the COVID-19 pandemic. In April 2020, the Parliament approved amendments to the State Budget of Ukraine, according to which almost all environmental measures were deprived of funding, funds were withdrawn from the reserve of the Energy Efficiency Fund. In May 2020, the Government approved the Economic Incentive Program to overcome the consequences of the COVID-19 Epidemic, which provides for increased production of own energy resources and "prevention of setting inflated national targets for reducing CO2 emissions." These steps have caused great concern and opposition from the public.

In the nuclear power industry with the election of the new Government, the project “Energy Bridge (Energomist) Ukraine - EU” was suspended. It envisaged the supply of capacity of Khmelnitsky NPP Unit 2 to the European Union's grid system by its inclusion in Burshtyn's power island and export of electricity from it to Poland. In November 2019, the Minister of Energy and the Environment stated that European consumers had no confirmed interest in this. The project also criticized Ukrenergo for not being in line with Ukraine's interests in terms of integration of the domestic grid to the pan-European ENTSO-E grid. In addition, the Ministry of Energy has questioned the feasibility of completing two Khmelnitsky NPP units (Units 3 and 4) and pointed to the lack of funds. As a result, projects that have raised many issues from the public are currently not being implemented.

Probably, the most important test of 2019 for the Ministry of Energy was signing of a new agreement with Russia concerning the transit of gas through the territory of Ukraine. Under favourable conditions (US blocking the construction of North Stream-2, Gazprom's financial debts), the negotiations ended with a 5-year agreement between Naftogaz and Gazprom, which secured minimum transit volumes. Gazprom also paid $ 2.9 billion to Naftogaz under a Stockholm arbitration ruling. Meanwhile, Russia continues to look for opportunities to complete the Nord Stream-2, which is a direct competitor of the Ukrainian gas transportation system, as soon as possible.

Despite the priorities announced by the Government, the popular state program for support of energy efficiency “warm loans” has proved to be underfunded: only UAH 400 million has been allocated to it in the 2020 state budget. At the same time, the Government declared its support for the Energy Efficiency Fund and continued its important work on the implementation of Directive 2012/27/EU on Energy Efficiency.

2. Current challenges / issues in the relevant policy area

INDEPENDENCE OF THE REGULATOR. Economically justified tariffs can only be determined by an economically and politically independent regulator. But in late 2019, the Verkhovna Rada of Ukraine adopted a bill that threatened the independence of the National Commission for State Regulation in the Fields of Energy and Public Utilities. The status of the regulator was changed from an independent state collegiate body to a central executive body with a special status subordinate to the Government. Despite trying to consolidate some of the independence of the new body, the real possibility of the Commission being an equal arbiter between the Government and market participants, while remaining part of the executive branch, is questionable.

ENERGY MARKETS. While energy market reform shows some progress, recent steps towards liberalization are still ahead, and the Government continues to secure itself by regulating the prices.

Transition of electricity from the pool model with the sole buyer of SE “Energy market” («Енергоринок») to the free market and stock exchange of electricity has not been finalized yet. Instead, a new state monopoly was created - the Guaranteed Buyer SE («Гарантований покупець»), which through the PSO (Special Duties) mechanism, resells most of the electricity in the Ukrainian market and sets prices on the market a day in advance. This distorts competition, but keeps the tariffs for the population unchanged. The imperfection of the rules of the wholesale electricity market and the lack of effective containment mechanisms distorts its functioning.

According to the agreements with the International Monetary Fund, in summer 2020, the gas supply market for domestic consumers should have been fully liberalized. Opening the market provides the ability to change the gas supplier. The issue of debts of certain types of consumers, including heating companies, and their repayment at market prices remains unresolved. Only after that it will become clear whether the Government is ready to take such a step by setting economic goals above the political ones.

SUBSIDIZATION AND ALLOWANCES. The state coal sector is completely dependent on state budget subsidies and still remains in the deep crisis. Subsidies and benefits for public utilities continue to be estimated at tens of billions of hryvnias. At the same time, the scaling of energy efficiency measures is very slow and the “warm credits” program is underfunded. The monetization of subsidies to the population is also not finished, and the benefits are almost unmonetized.

GREEN TARIFFS VS. AUCTIONS. Due to a change in the renewable energy support model and the transition from green tariffs to auctions in 2019, investors have stepped up the construction of new solar and wind power plants. As a result, in a year, more renewable energy capacities were built than in all previous years, and in November-December 2019 UAH 1.4 billion was lacking to pay for green tariffs. As of early 2020, the issue of debt growth to producers remained unresolved and was critical for Ukraine’s investment image. After several months of negotiations between the Government and investors in June 2020, a memorandum with individual investors in "green" energy was signed, and in July a law to implement that decision was passed. As a result, the "green" tariff was reduced by 15% for solar power plants and 7.5% for wind power plants. At the same time, the Government has pledged to repay the debt to green energy producers by the end of 2021, which already amounted to about UAH 14 billion this summer.The first "green" auctions were scheduled for April 2020 and were due to take place through the ProZorro.Sales platform. However, as of September 2020, the system is still not operating.

ENERGY EFFICIENCY. Along with the continued underfunding of the state's Warm Credit Program, the Energy Efficiency Fund began operations only at the end of 2019 and will need time to become popular with the housing cooperatives. As of 2019, more than 70% of Ukraine's population is unaware of the existence of government programs to support energy efficiency. This indicates insufficient communication by the state about the available energy saving opportunities and the importance of implementing energy-saving measures. Meanwhile, the key sectoral Law on Commercial Accounting (passed in 2017) is not being implemented, and not all households are paying for the consumed energy resources (heat, water, gas).

TRANSPARENCY OF THE INDUSTRY. The Energy Transparency Index of Ukraine for 2019 amounted to 48 out of 100. Despite some progress compared to previous years, industry-wide disclosure leaves room for improvement, especially in terms of natural gas and electricity markets. The Law on Transparency in Extractive Industries passed in 2018, which envisaged the publication of data on mining of national importance, was not being implemented starting from 2019. Increasing the openness of the sector will, on the one hand, help to increase consumer awareness and protect their rights, and, on the other, improve competitiveness by reducing the risks of doing business, which is an important factor for potential investors. In the field of electricity, Ukraine has begun to publish open data on the ENTSO-E Transparency Platform, but with considerable delay and not in full.

3. Recommendations for priority actions in 2020-2021, in particular, for the agenda of Parliament's second session

The six reform principles outlined in the 2019-2023 Toronto Principles remain relevant.

3.1. Availability and energy efficiency:

• providing consumers with energy resources at affordable prices, following the principles of protecting vulnerable consumers, energy efficiency and minimizing the negative impact on the environment;
• implementation of the Law on Commercial Accounting as a major step towards the implementation of energy-efficient measures in the housing sector;
• the adoption of the Law on Energy Efficiency, which will ensure significant progress in closing gaps in the implementation of Directive 2012/27/EU;
• ensuring proper governmental support of the energy efficiency measures for the population (the “warm credit” program, the Energy Efficiency Fund and others);
• proper communication of reforms and available support programs to the population.

3.2. Competitiveness of energy markets:

• completion of the electricity market reform: a complete transition from the sole proprietor pool of SE “Energy market” to the free market and electricity trading;
• completion of the gas market reform: full liberalization of the gas market for domestic consumers;
• open-market competition with access for new players;
• integration with pan-European markets;
• ensuring effective independent regulation for natural monopolies;
• quality control of energy resources and services.

3.3. Cancellation of government grants and subsidies:

• formation of prices in the energy markets based on the balance of supply and demand, the rejection of state subsidies to the sector;
• full monetization of subsidies and benefits for the population.

3.4. Transparency and openness:

• ensuring political and economic independence of the National Commission for State Regulation in the Fields of Energy and Public Utilities;
• ensuring the transparent functioning of the energy sector, including the proper management of natural resources, as well as the proper and comprehensive openness of the data;
• implementation of the Law on Provision of Transparency in Extractive Industries.

3.5. Improving policy coordination:

• ensuring consistency between strategic documents and key industry institutions;
• establishing effective synergies and promoting good governance between all public institutions responsible for developing and implementing public sector policies;
• integration of energy and environmental strategies, stimulation of emission reductions by energy producers;
• accessibility and sustainable implementation of the developed state policies;
• ensuring the proper implementation of European legislation in all energy sectors.

3.6. Energy independence:

• increase of energy production from own energy resources, with priority for development of renewable sources;
• ongoing dialogue with communities in the coal mining regions, promoting social development through the adoption of socio-economic support programs for the regions with closing mines, and setting up a special Commission on Structural Change, which will include representatives of state and local government, business, science, trade unions and non-governmental organizations;
• ensuring a sustainable and efficient use of energy infrastructure, in particular the gas transportation system;
• comprehensive preparation for the integration of Ukrainian energy system into the European ENTSO-E, modernization of mainstream networks and substations;
• balanced development of renewable energy sources as a priority for the development of generating capacities in the electric power industry;
• providing protection against inflation for the Reserve Decommissioning Fund (RDF) for the nuclear power plants and revising the Concept of Decommissioning in the direction of increasing allocations to the RDF;
• preparation for the full integration of regional electricity markets, increasing interstate trade, deepening scientific and technical cooperation with the European Union in the field of electricity digitization.